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95th Congress 1 COMMITTEE PRINT 

2d Session 


An Explanation for Emplo 

Prepared by the Staff of 


Russell B. Long, Chairman 


Printed for the use of the Committee on Finance 

35 ~°35 WASHINGTON : 1978 

For sale by the Superintendent of Documents, U.S. Government Printing Office 
Washington, D.C. 20402 

Stock No. 052-070-04736-4 


Louisiana, Chairman 

HARRY F. BYRD, Jr., Virginia 

Michael Stern, Staff Director 

George W. Pritts, Jr., Minority Counsel 

John E. Curtis, Jr., Counsel 

CARL T. CURTIS, Nebraska 
WILLIAM V. ROTH, Jr., Delaware 




Introduction 1 

What is an ESOP or TRASOP? 1 

How does an ESOP work? 1 

How does a TRASOP work? 2 

What do employees get as part of the ESOP or TRASOP? 2 

What do I own in the ESOP or TRASOP? 3 

'When do I receive what I own from the ESOP or TRASOP? 3 

What can I do with my shares of employer stock from the ESOP 

or TRASOP? 4 

How does the ESOP or TRASOP help my employer? 5 

Summary 10 

Digitized by the Internet Archive 
in 2013 

ESOPs and TRASOPs— An Explanation for Employees 


Since 1974, the United States Congress has by legislation created two pro- 
grams which are designed to give employees the chance to acquire a stock 
ownership in their employer. In the Employee Retirement Income Security 
Act of 1974, Congress first defined the employee stock ownership plan, or 
"ESOP" as it is usually called. In the Tax Reduction Act of 1975, and the 
Tax Reform Act of 1976, Congress implemented, and expanded, a different 
form of employee stock ownership plan, usually called a "TRASOP." The 
ESOP and TRASOP provide stock ownership for each employee without 
requiring the employee to spend any of his own money; his investment is the 
time and effort he puts into his job to make his employer profitable. Al- 
though some ESOPs and TRASOPs permit or require employees to put 
money into the ESOP or TRASOP, most provide that the employer will 
make all necessary ESOP and TRASOP payments. 

What Is An ESOP or TRASOP? 

An ESOP or TRASOP is an employee benefit plan which is "qualified" 
under the Internal Revenue Code. That is, it has been written in such a way 
that it satisfies the requirements of the Internal Revenue Code. As a qualified 
plan, the ESOP or TRASOP is required to be operated for the "exclusive 
benefit" of participating employees (and their beneficiaries). 

How Does an ESOP Work? 

The ESOP is designed to acquire stock of an employer for the benefit of 
employees. To do so, the ESOP may borrow money from a bank or other 
lender (including the employer) . The stock is bought directly from the em- 
ployer or from shareholders. When the ESOP borrows money, the employer 
guarantees to the lender that the ESOP will repay the loan. Employees are 
never required to assume any obligation for the repayment of the money 
borrowed by the ESOP. The employer is required to make annual payments 
to the ESOP in an amount at least equal to the amount the ESOP must pay 
on the money it borrowed. These amounts are then paid by the ESOP to the 
lender each year. 


The employer is also permitted to make additional payments of cash or 
stock to the ESOP each year. The amount of these additional payments is 
usually decided by the board of directors of the employer. Because the ESOP 
is "qualified," the employer gets a tax deduction for all payments to the 
ESOP, up to a maximum limitation established by the Internal Revenue 
Code. This tax deduction is available for the required employer payments 
and any additional payments, and its effect is to reduce the annual cost of the 
ESOP to the employer. Cash put into the ESOP by the employer will be 
used primarily to purchase employer stock. In addition, this cash may be in- 
vested temporarily in savings accounts or certain other permitted invest- 

How Does a TRASOP Work? 

An employer which adopts a TRASOP may claim a tax credit against its 
Federal income taxes if it makes payments of its stock, or cash which is used 
to purchase its stock, to the TRASOP. The amount of the credit which the 
employer may claim is limited by law, and part of it may only be claimed 
if the employees make payments to the TRASOP which match the pay- 
ments made by the employer. Only employers which buy things like 
equipment and machinery are generally able to adopt a TRASOP, because 
the tax credit is based upon the amount spent for things like capital equip- 
ment and machinery. 

What Do Employees Get as Part of the ESOP or TRASOP? 

Each year, all amounts of cash and employer stock paid by the employer 
and employees to the ESOP, and employer stock bought with cash held in 
the ESOP, are allocated among the accounts of employees who are partici- 
pating in the ESOP. This allocation is usually done on a formula related to 
each employee's salary or wages as compared to the salaries or wages of all 
other participating employees. Take as an example an employee who earns 
$10,000 per year from a company where the total salaries of all participating 
employees equal $500,000. That employee's salary or wages is 2 percent of 
the total, and so his share of allocations of cash and employer stock under 
the ESOP for that year would be 2 percent. If the employer contributed 
$100,000 to the ESOP during the year, the employee's share would be $2,000. 

A trust will be established (under the ESOP) to hold the cash and em- 
ployer stock paid to the ESOP for the benefit of employees (and their 

beneficiaries) . It is created by a separate written trust agreement and will be 
administered by a trustee. This is done to assure that each employee's interest 
in ESOP assets will be protected. 

Under a TRASOP, allocations to employees' accounts is done in the same 
way as under an ESOP, except that the maximum of any employee's salary 
or washes which can be taken into account under a TRASOP is $100,000 
each year. 

What Do I Own in the ESOP or TRASOP? 

An ESOP, like most employee benefit plans, is designed to benefit em- 
ployees who remain with the employer the longest and contribute most to 
the employers success. Therefore, an employee's ownership interest in cash 
and employer stock held in the ESOP is usually based on his number of years 
of employment with the employer. The employee's ownership interest in the 
ESOP is called his 'Vested interest," and the language in the ESOP which 
determines his vested interest is called a "vesting schedule." Although there 
are manv vesting schedules which may be used by an ESOP, most vesting 
schedules are set up so that the longer an employee stays with the employer, 
the greater his vested interest becomes. 

If an employee terminates employment with the employer for any reason 
other than his retirement, or, in some cases his death, his vested interest will 
be determined by looking at the vesting schedule and measuring how many 
years he has worked for the employer. All cash and employer stock in which 
he does not have a vested interest because he has not worked for the em- 
ployer for enough years will be treated as a "forfeiture," to which the former 
employee will not be entitled. Forfeitures are usually allocated among the 
ESOP accounts of the remaining employees on the same basis as employer 
payments to the ESOP are allocated. 

The vesting schedule applies only where an employee does not end his em- 
ployment because of retirement or, in some cases death. If an employee 
retires, or. in some cases if he dies, he will immediately have a 100-percent 
vested interest in all ESOP assets held for him. 

Under a TRASOP, each employee automatically has a 100 percent vested 
interest in all amounts which he or his employer contribute to the TRASOP 
and which are allocated to his account. Therefore, there are never any for- 
feitures under a TRASOP. 

When Do I Receive What I Own From the ESOP or TRASOP? 

Even though employer stock and cash are usually put into the ESOP or 
TRASOP for an employee each year, and put into a special account under 
his name, he will normally not be able to actually get any employer stock 
and cash from the ESOP or TRASOP until after his employment with the 
employer terminates and he ceases to be a participant in the ESOP or 

After an employee's participation in the ESOP or TRASOP ends, he (or 
his beneficiary) will be eligible to receive a payment of his vested interest. 

There are many permissible times and methods for making the payment to 
him from the ESOP or TRASOP. For example, it may provide that payment 
will be made as soon as possible after an employee's termination of employ- 
ment. On the other hand, it may require that any payment be deferred until 
some later time, such as the employee's death or his normal retirement date. 
However, payment of a former employee's vested benefit must start soon 
after his death or attainment of age 65. Payment may be made to a former 
employee (or his beneficiary) in a lump sum, or it may be made in 

Payment of an employee's vested interest from an ESOP or TRASOP 
may be made in cash or employer stock, as determined under the ESOP or 
TRASOP, subject to the right of the former participant (or his beneficiary) 
to demand a distribution of his benefit in shares of employer stock. 

What Can I Do With My Shares of Employer Stock From the ESOP or 


Once a former employee (or his beneficiary) gets his shares of employer 
stock from the ESOP or TRASOP, they are his property and he can do what 
he wants with them. He can vote the shares of employer stock at sharehold- 
ers' meetings, receive any dividends paid on the stock by the employer, and he 
may keep the stock as long as he wishes. 

However, if he wishes to sell or otherwise transfer ownership of the stock 
to a third party, he may be required by the terms of the ESOP or TRASOP 
to first offer to sell the stock to the employer and the ESOP or TRASOP. 
This requirement is called a "right of first refusal" for the employer and the 
ESOP or TRASOP; they can exercise this right and purchase the employer 
stock at its fair market value. Generally, the price offered by the prospective 
buyer or the price at which the stock is publicly traded would establish the 
fair market value for the stock. The purpose of this right of first refusal is to 
protect the employees or the employer by preventing the stock from 
being acquired by outside parties who have no interest in the employer or the 
ESOP or TRASOP and to protect the employer whose stock is closely held 
from violating any Federal law as a result of having its stock sold when it 
does not satisfy certain Government rules. 

In addition, at the time the former employee (or his beneficiary) receives 
employer stock which is not publicly traded from the ESOP or TRASOP, he 
must be given a "put option," the right to demand that the employer buy 
his shares of employer stock at their fair market value. In such a case, the 

ESOP or TRASOP may provide that the ESOP or TRASOP may buy the 
employer stock, although the ESOP or TRASOP may not be required to buy 
the stock under the put option. The purpose for including a put option is 
to assure that each former employee (or his beneficiary) will have someone 
available to buy his shares of employer stock if he wishes to sell. 

How Does the ESOP or TRASOP Help My Employer? 

The employer benefits primarily from the favorable tax treatment it re- 
ceives for all payments made to the ESOP or TRASOP. As explained before, 
an employer receives a tax credit for amounts paid to a TRASOP and 
a tax deduction for amounts paid to an ESOP. This is very important 
when the employer uses the ESOP as a means of borrowing money. In order 
to understand how the use of the ESOP to raise money benefits the employer, 
a comparison must be made with the usual method of borrowing money. 

If an employer which does not have an ESOP wishes to borrow money to 
build a new building, expand production, or for any other reason, the em- 
ployer would go to a bank to borrow money. When the employer repays the 
loan, it will also pay interest on the loan, just like an individual person would 
do with a charge account. Although the interest payments would be tax 
deductible, the principal payments on the loan would not. This means that 
the employer would first figure its taxable income, then pay its income taxes, 
and then make its payment on the loan. 

The use of an ESOP for this purpose greatly helps the employer because of 
the effect it has on the employer's taxes. 

In this situation, the ESOP borrows the money from a bank, and signs 
a promissory note for the money: 



As part of the ESOP loan, the employer gives a written guarantee to the 
bank, promising that the ESOP will repay the loan and that each year the 
employer will pay to the ESOP enough money to permit the ESOP to make 
its annual repayment of the loan : 








The ESOP then uses the money from the loan to buy stock from the em- 
ployer : 





Each year, the employer makes a tax-deductible payment to the ESOP, 
sufficient to let the ESOP make its annual debt repayment to the bank: 










The effect of this transaction is to allow the employer to borrow money 
from a lender and repay the loan with tax-deductible dollars. Since the prin- 
cipal and interest repayments are deducted before the employer's taxable 
income is determined, the taxable income is lower than through regular 
borrowing and the employer's taxes are reduced. 

Since the major portion of the ESOP or TRASOP assets are used to buy 
employer stock, the value of each employee's ESOP or TRASOP benefit is 
directly tied to the financial success of the employer. Also, the employer, as 
a result of the use of an ESOP or TRASOP, benefits because employees 
understand that their work performance directly affects the financial suc- 
cess of the employer and the value of ESOP or TRASOP assets. After all, 
they now own part of the company. This should encourage employees to 
work more productively and increase the profitability of their employer. 

Another benefit to the employer is that the ESOP provides its shareholders 
with a buyer for their stock if they wish to sell. For stockholders of a small 
employer, this is a tremendous advantage, and it could also assist the em- 
ployer in attracting additional investors. 


The adoption of an ESOP or a TRASOP provides benefits iur the em- 
ployer, its shareholders and its employees. Our tax laws encourage the estab- 
lishment and use of ESOPs and TRASOPs. Congress has passed seven laws in 
the past 6 years to encourage employers to consider ESOP and TRASOP. 
Will it continue? Senator Russell B. Loner, chairman of the Senate Finance 
Committee, has repeatedly stated: "Just as in 1862, when Congress passed 
a law to allow Americans who had very little money to own and develop up 
to 160 acres of land, we should now give Americans the opportunity to 
become owners of our growing frontier of new capital (stock) . The way to 
do this is through laws which encourage the development of programs like 




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